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Create Date January 1, 1999
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By Kenneth Costello, Associate Director for Electric and Gas Research
January 1999

A key feature of energy utility industry restructuring allows residential and small
commercial customers the opportunity to choose their supplier for designated
unbundled services. Previously, these services were provided on a bundled basis by
the local utility. The expectation is that retail customers will benefit from the competition
induced by unbundling. This presumes that customers will make rational choices in
selecting a third-party provider.
This report focuses on the first phase of consumer choice for small retail gas
customers.1 Enough evidence has accumulated for gas customer choice programs,
most of which are pilot in nature and initiated by gas utilities, to make some general
assessments about consumer interest. 2 These programs, several of which began in the
fall of 1996, show varying results. They suggest that most small gas customers are
reluctant to relinquish bundled sales service provided by their local gas utility even
when alternate service would result in bill savings.
A major policy issue revolves around the concern of many observers that the
vast majority of eligible residential customers have stayed with their current supplier of
bundled sales service, namely the local utility. This behavior of customers appears
rather odd in view of expected or sometimes even guaranteed bill savings. Three
alternative possible explanations come to mind. First, some customers made well
1 The next phase, which has already begun in some states, will allow more customers to
informed decisions, correctly anticipating no net benefits from choosing an
unencumbered marketer (for example, even with guaranteed savings, customers will
have to incur switching costs and may perceive a marketer's service, even the local gas
utility's marketing affiliate, to be inferior to the utility's). Second, some customers may
be so confused and uninformed, that they decide to incur no search costs and to simply
"stay put," even though there may be imputed positive net benefits. It should be noted,
however, that such an information problem may only be temporary: marketers and other
non-utility entities will have an incentive to overcome customer confusion and lack of
customer information. Third, discriminatory actions by the local gas utility may prevent
or discourage customers from switching to a marketer - onerous certification
requirements, for example, may decrease the number of new marketers.
This report suggests that one or more of these explanations probably has some
validity for a given program and situation. Problematic for regulators and other
policymakers are explanations two and three, which justify actions improving consumer
information and "leveling the playing field." Explanation one assumes a properly
functioning market where well-informed consumers are making rational decisions in a
marketplace where all suppliers have an equal opportunity to compete.
The evidence from various programs coincides with economic theory saying that
the savings must be adequate to offset the risks and transaction costs associated with
consumers switching to a new provider, this condition is especially relevant 'in a market
where the local utility has been the sole provider and the only entity with name
recognition. Overcoming this so-called first-mover advantage, which is not necessarily
problematic, makes it more difficult for independent marketers to establish themselves
and create a presence that erodes the dominance of the incumbent utility. In all
markets, incumbents have an inherent advantage over new entrants; one reason
derives from the positive reputation of an incumbent (if that is in fact true), which a new
entrant must try to neutralize with advertising and other informational activities.
Consumers, in turn, have to incur higher costs to acquire information on new entrants.
The outcomes of gas customer choice programs also seem to be influenced by
the "little things" in terms of program design and implementation. For consumers to
participate, they need to be adequately informed and educated and their transaction
costs need to be minimized. Rational behavior for many if not most gas customers may
involve staying with their current supplier, the local gas utility: the net benefits of
switching, after adjusting for uncertainty and other relevant factors of consumer
decisionmaking, may well be negative. To some observers, this outcome raises the
fundamental issue of whether competition reflected by the entry of new suppliers is
actually beneficial to society.
FinallYI the evidence from gas customer choice programs provides lessons
learned that can be extrapolated to future consumer choice programs of both natural
gas and electric utilities. Although customer participation may not always be an
enviable goal, it is consistent with the widely-held perception that many customers will
benefit from choosing non-utility providers. Existing, as well as past, gas customer
choice programs provide insights into the requisite conditions for customers to switch
away from the incumbent utility provider.

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